Krugman and Obama’s Dangerous Austerity Myths

By William K. Black

Austerity in response to the Great Recession has proven to be an economic weapon of mass destruction.  On January 10, 2013, Paul Krugman (Nobel Laureate in Economics) and President Obama launched the same dangerous austerity myth in remarkably similar language.

January 10, 2013
Coins Against Crazies
By PAUL KRUGMAN

“Lately, revenue has fallen far short of spending, mainly because of the depressed state of the economy. If you don’t like this, there’s a simple remedy: demand that Congress raise taxes or cut back on spending. And if you’re frustrated by Congress’s failure to act, well, democracy means that you can’t always get what you want.”

Remarks by the President in Nomination of Secretary of the Treasury

“And thanks in large part to [Treasury Secretary Geithner’s] steady hand, our economy has been growing again for the past three years, our businesses have created nearly 6 million new jobs.

And we’ve begun to reduce our deficit through a balanced mix of spending cuts and reforms to a tax code….”

I know that many, perhaps most Americans, would read these quotations and think:  “of course, they’re repeating obvious truisms.”  Both quotations are, however, dangerous myths.  My colleagues at UMKC who specialize in macroeconomics have been discrediting these myths for many years, and Krugman has come to the same viewpoint.  Randy Wray has just published a book on the subject.  Every time someone reads it a Pete Peterson acolyte loses his wings.

L. Randall Wray.  Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems (2013).

Krugman knows what he wrote is a dangerous myth.  I assume he fell victim to limits on the word count of his column and did not have time to reiterate the point he has made many times as to why trying to balance the budget in our situation would likely cause a recession.

I have explained many times the reason why austerity in response to the Great Recession is a lose-lose-lose-lose-lose-lose proposition.  The losses that austerity causes include reversing growth, causing a recession and increasing unemployment, poverty, inequality, misery (by cutting spending programs for those in need at the time they most need them) and budget deficits.

In a recession, demand is inadequate to produce full employment.  The Great Recession caused severe unemployment and a massive loss of income and wealth – above $12 trillion in the household sector.  This reduces demand by trillions of dollars – well below the level of demand required for full employment.  A Great Recession will cause a dramatic rise in the federal budget deficit because revenues will fall sharply and the demand for government services in the form of unemployment compensation, Medicaid, and food stamps (SNAP) increase.

Austerity consists of some mixture of (net) tax increases and (net) government spending cuts.  (Net) tax increases reduce already inadequate private sector demand.  (Net) spending cuts directly reduce public sector demand and indirectly reduce private sector demand.  The vast majority of government spending does not go to paying compensation to government employees, but to private contractors and vendors.  All these recipients then spend, adding to demand for consumption and investment.  Increased government spending leads private sector employers to increase hiring and helps produce a recovery from the Great Recession.  Austerity has the opposite effect.  It is pro-cyclical – it makes the recession more severe and long-lasting by simultaneously reducing already inadequate private and public sector demand.  As the recession becomes more severe, underemployment increases – decreasing government revenues and increasing the need for government spending for programs like unemployment compensation, Medicaid, and food stamps (SNAP).  This can lead to increased federal deficits.  One of the unintended consequences of austerity programs designed to decrease the deficit is that they can increase the deficit – and inflict catastrophic economic, social, and psychological harm.

This explanation demonstrates why Krugman is propagating a myth when he writes that austerity is a “simple remedy” to a budget deficit driven overwhelmingly by the Great Recession.  It is far more likely that inflicting austerity will constitute the economic analog to bleeding a patient – malpractice born of ignorance of how systems actually work.  Both forms of malpractice make the patient (economy and deficit) sicker.

Obama spread the same dangerous myth about austerity.  Obama’s initial policy was influenced primarily by his principal economic advisers, Larry Summers and Christina Romer.  They favored stimulus and understood it needed to be much larger than the amount that the White House felt could be passed.  Over time, however, Treasury Secretary Geithner became far more dominant as the strength of his personal relationship with President Obama grew.  Geithner was a Republican who had become an Independent as a fig leaf.  He shared the views of so many elite bankers who he had served as President of the Federal Reserve Bank of New York.  Geithner wanted austerity, including severe cuts to social programs and the safety net.

From the WashingtonPost WonkBlog:

“From Zach Goldfarb’s excellent profile of Treasury Secretary Timothy Geithner’s success inside the Obama administration:

The economic team went round and round. Geithner would hold his views close, but occasionally he would get frustrated. Once, as [then chairwoman of the Council of Economic Advisers Christina] Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was ‘sugar,’ and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt.

Wrong, Romer snapped back. Stimulus is an “antibiotic” for a sick economy, she told Geithner. ‘It’s not giving a child a lollipop.’

In the end, Obama signed into law only a relatively modest $13 billion jobs program, much less than what was favored by Romer and many other economists in the administration.”

Geithner is not an economist and what he “knows” about economics is mostly dangerous myths.  That is one of the reasons why Geithner was such a major contributor to never detecting or countering the epidemic of accounting control fraud that drove the financial crisis, hyper-inflated the housing bubble, and produced the Great Recession.  It took some significant arrogance or sexism to tell one of the nation’s most famous macro-economists that she was 180 degrees wrong about macro-economics.

The “$13 billion jobs program” is a sick joke as a response to the Great Recession.  Our central economic problem is jobs.  The central jobs problem is not a lack of training – it’s a lack of demand.  If consumers don’t buy, employers don’t hire.  The inadequacy in demand is measured in the trillions of dollars.  A trillion is a thousand billion.  A $13 billion program is one-one-hundredth of the appropriate size to begin to deal with the Great Recession.  Why not adopt a federal jobs guarantee program that ends the waste and injury of people willing and able to work being kept idle?  Why is it politically possible to pay people not to work but not to give productive jobs to those who want to work and are able to do so?

President Obama’s comments show that he does not understand these issues.  First, he credits job gains to Geithner’s “steady hand.”

“And thanks in large part to [Treasury Secretary Geithner’s] steady hand, our economy has been growing again for the past three years, our businesses have created nearly 6 million new jobs.”

The opposite is true.  Had Geithner had his way and inflicted austerity on us we, like the Eurozone, would have been thrown back into recession and unemployment and misery would be rampant.  Three Eurozone nations, Spain, Italy, and Greece, have Great Depression levels of unemployment, particularly among their young.  Had Geithner gotten his way and inflicted self-destructive austerity Mitt Romney would now be President and the Republicans would control the Senate.  If Geithner had not helped block the push by Romer and Summers within the administration for greater stimulus the U.S. recovery would be far more robust and millions more Americans would be employed.  (In fairness, the Republicans and conservative (“Blue Dog”) Democrats who killed the revenue sharing portion of the stimulus bill and insisted that much of the stimulus had to be in the form of the extension of tax cuts for the wealthy, which have a far smaller stimulus effect than alternatives, also cost millions of Americans their jobs.)

Geithner led the administration’s push to end the single-most effective stimulus program – not collecting the full payroll tax.

The payroll tax is an extremely regressive tax, so the partial tax “holiday” was particularly effective in getting cash into the wallets of those who most needed the money and were most likely to spend it on their pressing needs.  (A Federal Reserve study was recently released showing the “multiplier” (stimulus) effect of the “holiday” was even greater than anticipated.)  Collecting the full tax, which resumed in January 2013, is an act of austerity.

“Independent analysts say that the expiration of the tax cut could shave as much as a percentage point off economic output in 2013, and cost the economy as many as one million jobs. That is because the typical American family had $1,000 in additional income from the lower tax.”

Geithner led the charge raise the tax and kill the million jobs.

“‘This has to be a temporary tax cut,’ said Timothy F. Geithner, the Treasury secretary, testifying before the Senate Budget Committee this year and voicing the view of many in the White House and on Capitol Hill. ‘I don’t see any reason to consider supporting its extension.’

The White House has not pushed for an extension.”

Where we saw a million reasons to continue the tax cut, Geithner was unable to see “any reason.”

The federal budget deficit is falling.  It fell in absolute dollars in FY 2012.  As a percentage of GDP, it has fallen every year since 2009.  The deficit fell from 10% of GDP in 2009 to approximately 7% in FY 2012.  That is a 40 percent reduction in the deficit as a percentage of GDP during the Great Recession and early years of the recovery.

Paul Krugman authored at least two columns dated January 10, 2013 (at least on their web versions).  The column, entitled “The Mostly Solved Deficit Problem” both refutes and propagates the myth I have been discussing.

Here is the key sentence that embodies the incoherence.  The context is that he is reporting the projections of the Center on Budget and Policy Priorities (a group of pro-austerity deficit hawks).

“As long as the economy recovers, which is an assumption built into all these projections, the debt ratio will more or less stabilize soon.”

But that is precisely what CBPP cannot “assume” because CBPP purports to analyze austerity policies.  Inflicting those policies is precisely what would reverse the recovery and send us back into recession and increase the deficit.  The policy that is “solving the deficit problem” is not inflicting austerity on the Nation.  If we continue that policy and regain full employment we will continue to reduce the deficit “problem.”  Krugman, however, treats a CBPP myth as if it were fact:

“CBPP goes on to advocate another $1.4 trillion in revenue and/or spending cuts, which would bring the debt ratio at the end of the decade back down to around its current level.”

CBPP’s austerity plan would do the opposite.  It is a weapon of mass economic destruction.

The deficit fell because we improved our recovery through the “automatic stabilizers.” These stabilizers do not need new legislation to create them, so they act “automatically” to respond to a recession (or inflation).  In a recession, the stabilizers work in a counter-cyclical (stimulus) fashion to make recessions less severe and long-lasting.  The stimulus program expanded this stimulus.  As economic growth increases due to the increased demand, unemployment falls and revenues rise while expenditures for the unemployed fall.  The result is that the federal budget deficit falls.  Had we followed Geithner’s advice and inflicted austerity we would be back in recession and facing growing deficits.

Obama’s next statement about Geithner and Lew compounds the harmful myth of austerity.

And we’ve begun to reduce our deficit through a balanced mix of spending cuts and reforms to a tax code….”

No, the U.S. was reducing at a moderate clip its deficit as a percentage of GDP due to economic growth.  Stimulus increased that growth and acted to reduce future budget deficits.  The overall reduction in the deficit (from 10% to 7% of GDP) is very large and the cumulative reduction in the size of the deficit that Obama achieved relative to the increased deficits that Geithner’s and Jacob Lew’s preferred austerity myths would have inflicted are in the trillions of dollars.  To the extent that Obama has made (net) “spending cuts” and tax increases in response to the Great Recession he has slowed our recovery and likely increased our deficit (to list only two of the six harms characteristically inflicted by austerity).

18 Responses to Krugman and Obama’s Dangerous Austerity Myths

  1. Again, Bill hits the nail on the head. Keep hammering Bill, you just might get your point through the knotty wood.

  2. Raising the minimum wage from the current $7.25 per hour, which has been fixed since 2009, despite huge cost of living increase, would inject more money into the economy and actually create more jobs, despite protests from employers, who don’t like to see their profits take a temporary hit.

    By comparison France just raised its minimum wage to the equivalent of $12.33 per hour.

    Obama has seriously ignored the lower paid as if they are not worthy of consideration.

  3. All those acolytes of Peterson’s might be looking for a job one of these days. I say we save a job in the choir for each of them, which would give me no end of perverse pleasure. I hear the choir singing even now. http://www.youtube.com/watch?v=OagFIQMs1tw Let it bleed…. and pay for the deed!

  4. The only tax change I know of from 2009 to 12/31/2012 is the payroll tax holiday. What “reforms” is he talking about? Seems to me that tax rate CUT has been accompanied by an increase in revenue.

    And what spending cuts? According to Fred, spending has been pretty much flat-lined since 2010, at about $3.8T, having increased from $3.1T or so in 2008. As you say, the automatic stabilizer spending has gone down, meaning that the rest of it, the part he has control of, has gone up.

  5. Krugman is quite devious. I remember him saying that Glass-Steagall gave the US a sound banking system for almost half a century, yet the man has expressed nothing about the need to do away with these financial derivatives (toxic private money, as Varoufakis calls them), nor has he expressed any support for a re-separation between depository institutions and investment banks. He continues to downplay MMT, by trying to suggest that mmters are just adepts of blind spending. Often times I wonder who is truly paying his salary. But still, I have to follow the man on twitter. One needs dichotomy elements in order to ensure himself of being sane. That’s why I follow Ron Paul, as well. The man’s stance on imperialism, foreign wars, the “war on terror”, trade sanctions, NATO, the Military Industrial Complex, congressional and presidential powers is right on target. Though, life is ironic. It always has to be ironic, that the guy with the most sound policies in regards to diplomacy and conflict, is also an adept of austrianism. If someone could get hold of Ron Paul and show him all the facts, on which MMT is based upon, he would become a god among mere politicians. If the austerity ideology is not vanquished, we’re still going to be force to endure it, even after human society would have reached Vladimir Vernadsky’s noosphere, when – by the mastering of nuclear processes – humanity creates its own resources. Why big powers, who have monetary sovereignty, don’t engage investing in setting up 4th generation nuclear reactors and applying transmutational technology, is beyond me. Instead, we’re going for low-fixed energy flux density sources of power like wind and solar panels. We need high energy flux density sources of power, if we want sustain the future increasing population – all of it – at a decent standard worth living in.

  6. Mr. Black, ?????? I don’t get your claims that in his January 29, 2012 column Mr. Krugman was promoting the ‘virtues of austerity’. In fact I got quite the opposite starting with the tile of his piece, “The Austerity Debacle“. Can you be more specific?

    • readinamazement

      You are correct, IMHO. This author is trying a bit of sarcasm in his effort to revive the discredited austerity banter. It doesn’t work in the real world – abandoned in Europe after horrible results.

  7. Now Im confused. Can blogpost be called a “column”? Are all blogposts “columns”?

    I tought column was a regular feature that appears in newspaper.

  8. The big problem is the Democrats are stuck on stupid with taxes. Their whole platform is to raise taxes, which is austerity. They say it is just the rich, but that is a lie. It is rich, upper middle, middle class and the poor. They think the governmnet is revenue constrained. They are wrong.

    • readinamazement

      That’s hilarious – Geo Bush, is that you? More realistically, taxes are at historically low points that are impairing public infrastructure and education funding to the long-term detriment of the US.

  9. Everything I have ever read by Krugman is anti-austerity. The quote says that if you don’t like the fact that revenue has fallen far short of spending, you can do these things. He doesn’t suggest they should be done. In fact, he supports government spending to get out of the recession. Am I missing something?

    • His grandfather invented Kruger Rands ;-)

    • readinamazement

      I agree with your observations. The author is trying to revive the austerity tripe that has been discredited in rational circles. Maybe he should post on a non-economic website?

  10. Mr. Black, I’m a youngster of 61 so I have not lived long enough to witness government austerity.

    • Steve,

      When you get to be 65 you should be eligible for Social Security retirement benefits and Medicare insurance.

      Think about austerity some more.

      Right wingers are out to cut these benefits that you have already paid for.

  11. You say in your article that you have studied macro-economics. Can you explain why a private sector recovery was under way before the government spending of the “New Deal” in the thirties? There is a graph in the article:

    Sydenham’s Law of Public Expenditure and Economic Growth

    that shows clearly that the expenditure of the New Deal reduced a private sector recovery. The huge government expenditure in the Vietnam War had a similar effect.

  12. readinamazement

    That’s hilarious. The real myth, of course, is that austerity, trickle down, supply side or other voodoo economics has any validity. The best thing going for the austerity hacks was the now-discredited Harvard study which proved the contrary when the data was correctly run.